In a new paper, researchers examine equity strategies that exploit information in ESG ratings, following several papers that suggest that these strategies lead to outperformance.
While many of the ESG strategies have positive returns, adjusting these returns for risk shrinks "alpha" (or excess risk-adjusted return) to zero. In short, sector biases and exposures to equity style factors capture the returns of ESG strategies. In addition, the analysis suggests that returns are inflated when investor attention to ESG rises.
However, ESG fund performance is also attributable to rising investor attention. So the message is rather, do not buy the outperformance narrative, but consider ESG strategies for the unique benefits they provide such as hedging climate or litigation risk.
As climate regulation expands globally, the incremental pricing in of companies' negative environmental externalities will arguably become a greater driver of performance.
This is sales and trading commentary. It is not a product of UBS Research.
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